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Municipal Bonds: This Year's Hottest Investment Strategy

The unsexy municipal bond is the year’s hottest investment strategy.

CORE FUNDS

Steven Pikelny, a fund analyst at Morningstar, recommends Fidelity Intermediate Municipal Income (FLTMX) and BlackRock National Municipal (MDNLX), both of which weathered last year’s muni swoon better than competitors. The Fidelity fund was down 1.2% last year, the BlackRock fund lost 2.99%. They own exciting stuff like Clark County, NV, airport bonds that pay 5.75%. (Don’t knock it; next time you fly into Vegas you’ll look down at the tarmac with a special pride.) Schatsky also recommends the lower yielding Vanguard Limited-Term Tax-Exempt Fund Investor Shares (VMLTX), which managed to eke out a gain last year. Closed-end funds These are a special breed of fund that could offer more return, but the tradeoff is more risk. Closed-end shares trade throughout the day like stocks, and while their prices move up and down with their holdings, they’re also affected by the market’s sentiment toward whatever they hold. So if investors are bullish, they may pay more for the fund than its underlying assets are worth. When investors are bearish, they’ll pay less. At this writing, closed-end funds that own muni bonds were selling for 90–95 cents on the dollar. Pikelny warns that if interest rates continue to rise, investors in these funds can get hit hard, as they tend to own rate-sensitive bonds, and some borrow to juice returns—which can backfire if rates go up. Among his picks in the category is Nuveen Select Tax-Free Income (NXP), which doesn’t borrow and was selling for 6.6% less than the value of its holdings at press time.

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CLOSED-END FUNDS

These are a special breed of fund that could offer more return, but the tradeoff is more risk. Closed-end shares trade throughout the day like stocks, and while their prices move up and down with their holdings, they’re also affected by the market’s sentiment toward whatever they hold. So if investors are bullish, they may pay more for the fund than its underlying assets are worth. When investors are bearish, they’ll pay less.

At this writing, closed-end funds that own muni bonds were selling for 90–95 cents on the dollar. Pikelny warns that if interest rates continue to rise, investors in these funds can get hit hard, as they tend to own rate-sensitive bonds, and some borrow to juice returns—which can backfire if rates go up. Among his picks in the category is Nuveen Select Tax-Free Income (NXP), which doesn’t borrow and was selling for 6.6% less than the value of its holdings at press time.

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STATE-SPECIFIC FUNDS

Residents of high-tax cities in high-tax states face a special kind of hell at tax time. Not only does Uncle Sam take his share, but the local tax collectors also gnaw away at your hard-earned cash. If you fit into this category, consider a fund that specializes in bonds issued by agencies in your state. Fund company Vanguard, for example, offers low-cost funds for residents of California, Massachusetts, New York, Ohio, and other states. Keep in mind that these funds are, by their nature, less diversified, so that in the (highly unlikely) event of a default, you’d be at greater risk of losing money. The good news is that income from these bonds is “triple taxfree,” three words guaranteed to put a spring in your step.

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Jack Otter is the author of Worth It…Not Worth It? Simple & Profitable Answers to Life’s Tough Financial Questions.

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